On March 14, 2018, the Honourable Justice Michael Penny of the Ontario Superior Court of Justice released a decision granting a US$2.6 billion judgment to the SFC Litigation Trust for fraud and breach of fiduciary duty in its action against Allen Chan, the former CEO of Sino-Forest Corporation.
The Sino-Forest Success Story
Sino-Forest was a publicly traded company listed on the Toronto Stock Exchange with a market capitalization of approximately $6 billion at its peak. Its principal businesses included the ownership and management of forest plantations, the buying and selling of standing timber, wood logs and wood products, and the complementary manufacturing of downstream wood products.
By all accounts, Sino-Forest seemed like a remarkable success story. Between the 2003 and 2010 financial year ends, Sino-Forest’s revenue grew from $265.7 million to $1.9 billion (an approximately 625% increase) and its assets from grew from $418 million to $5.7 billion (an approximately 1,270% increase). Between August 2004 and October 2010, Sino-Forest used its apparent success to raise approximately $3 billion through debt and equity financing.
The Demise of Sino-Forest
On June 2, 2011 a short seller, Muddy Waters Research, published a report describing Sino-Forest as a “multibillion dollar Ponzi scheme ... accompanied by substantial theft.” Among other things, the report alleged that Sino-Forest did not hold the full amount of timber assets that it reported, that it overstated its revenue, and that it had engaged in undisclosed related-party transactions.
The same day that the Muddy Waters report was released, Sino-Forest’s Board appointed an Independent Committee to investigate the allegations contained in the report. In turn, the Independent Committee retained professional firms to assist with the investigation. After eight months of investigation, the Independent Committee released its final report on January 31, 2012, disclosing that the issues it examined, including timber asset verification and related party transactions and relationships, “proved very difficult to definitively resolve.”
Also following the Muddy Waters report, the Ontario Securities Commission (OSC) commenced an investigation into Sino-Forest. On August 26, 2011, the OSC issued an order containing allegations including that Chan, the CEO of the company, and other certain directors and officers “appear to be engaging or participating in acts, practices or a course of conduct related to its securities which it and/or they know or reasonably ought to know perpetuate a fraud.” Among other things, the order cease-traded Sino-Forest’s securities and required Chan and other members of management to resign. The OSC delivered a Statement of Allegations on May 22, 2012, alleging that Chan and other members of management “engaged in a complex fraudulent scheme to inflate the assets and revenue of Sino-Forest”.
In March 2012, Sino-Forest filed for protection under the Companies’ Creditors Arrangement Act, which led to the approval of a Plan of Arrangement by the Court. The Plan, among other things, transferred certain of Sino-Forest’s litigation rights to a Litigation Trust to pursue for the benefit of Sino-Forest’s creditors.
On March 31, 2014, the SFC Litigation Trust commenced an action against Chan alleging fraud and breach of fiduciary duty.
The Mareva Proceedings against Chan
On August 28, 2014, the SFC Litigation Trust obtained a worldwide Mareva order freezing all of Chan’s assets. Chan appealed the Mareva order to the Divisional Court, arguing that the Litigation Trust failed to establish that Chan had assets in Ontario. In a split decision released on March 28, 2017, the Divisional Court dismissed Chan’s appeal, holding that Mareva orders are justified by the Court’s in personam jurisdiction over the defendant, and not whether the defendant has assets in the jurisdiction.
Chan obtained leave to appeal the Divisional Court’s decision to the Court of Appeal on the issues of whether it was an error to grant a worldwide Mareva injunction where the defendant does not have assets in the jurisdiction, and whether it was an error not to require the plaintiff to post security to fortify its undertaking to the court and as security for costs, where it does not have assets in the jurisdiction. The appeal was scheduled to be heard March 28, 2018; however, the issues became moot once Justice Penny’s trial decision was released and Chan abandoned the appeal.
The Decision of Justice Penny
The trial was held in March, April and May 2017, with closing argument taking place over a week in July 2017. Three weeks of the trial were held in Hong Kong with Justice Penny sitting as commissioner to take the evidence of witnesses who resided in Hong Kong and mainland China.
Justice Penny released his decision finding in favour of the SFC Litigation Trust on March 14, 2018.
In the decision, Justice Penny found that Chan secretly controlled many of Sino-Forest’s counterparties (i.e. its suppliers and customers) through a complex network of relationships with third parties. The third parties acted as Chan’s “nominees,” holding positions as directors, officers, and shareholders on his behalf.
Justice Penny found that Sino-Forest’s primary business model under which it claimed to buy and sell forestry plantations within China was a fraud and that “Sino-Forest lacked the requisite documentation to find the standing timber assets, much less prove that it had any ownership interest in them.” Justice Penny also found that Chan defrauded Sino-Forest by causing it to fund deposits and advance payments to entities that Chan secretly controlled.
In the result, Justice Penny held that Chan was liable for US$2.6 billion in damages for fraud and breach of fiduciary duty, as well as punitive damages of Cdn. $5 million.
Damages recovered from Chan will go to the beneficiaries of the SFC Litigation Trust, being the creditors of the now defunct Sino-Forest.
On April 7, Chan served and filed a notice of appeal of Justice Penny’s decision. The appeal is pending.
Allen Chan was represented by Rueters LLP, with a team including Robert Rueter, Sara Erskine, Malik Martin and David Barbaree.